Wednesday, January 29, 2014

It's been a tiring, or should I say taxing, 24 hours. Last night at about this time (just after 6 pm as I type these words) a small group of us was heading to a really good local restaurant, Po on Cornelia Street in Greenwich Village, for our customary post-colloquium small group dinner. By 8:15 I was cabbing to Penn Station, in order to take the 9:05 pm Acela to Washington, DC, so that I'd be there for the American Enterprise Institute session on corporate tax reform that will soon become the topic of this post.

Bad evening on Amtrak, however. A two-hour train delay, poorly explained as it was ongoing, meant that I didn't get to my hotel room in DC until 2 in the morning. Then my train home today was cancelled, though I was able to scramble and get back in a timely fashion anyway.

But anyway, about the session. Entitleed "Corporate Tax Reform: Where to From Here?," it provided a platform for Laura D'Andrea Tyson, Martin Sullivan, and me to say where (if anywhere) we think things might be headed on this front, and why.

You can see the entire video of the event here. I believe it was reasonably lively. In addition, you can see the Power Point slides for my talk here.

Sullivan and I were comparably pessimistic, not just about the politics, but also about the overall merits of the types of corporate tax reform plans that are being floated today. Bad though the current system may be (and indeed is), it's such a tangled kind of a mess that efforts to take a couple of steps in one direction or another tend to have really serious drawbacks. It's a bit like Pin the Tail on the Donkey, when you've been spun around so many times that all you can do is stagger blindly in a circle, except that, in that game, there actually is a clear right direction, if only the dizzy and blindfolded participant could find it.

While we mainly discussed domestic corporate tax reform issues, we also spent some time on the international aspect, given how closely entangled those two strands are these days. Sullivan was kind enough to bring my international tax book to the session, and to several times hold it up and recommend it, with very kind accompanying remarks that I would certainly not, for my part, be inclined to quarrel with.

OK, at the end of my last post I had laid out the new view and noted Shaheen's reliance instead on managerial accounting incentives to explain lockout in the international realm. Managers of publicly traded companies love to have high financial accounting income, even at the expense of favorable economics, so I suppose they do all they can (bake cookies, issue firing threats) to persuade their accountants that particular foreign source income of their overseas subsidiaries has been permanently reinvested abroad. This causes the deduction from financial accounting income for the deferred U.S. repatriation tax to flip on a dime to 100% of what it would be if incurred today, to zero. Sounds really stupid as a matter of rule design, but I am not an accountant.

Anyway, once they declare PRE (permanently reinvested earnings) they can't bring it home without both (a) taking an earnings hit from the repatriation tax, if any, and (b) making the accountants feel disrespected and hence more skeptical about other PRE claims. So Shaheen posits that it's fruitful to think of the PRE as if it simply cannot come home.

Note, by the way, how bad for the shareholders this is. The PRE designation doesn't make actual taxes lower - it just causes the possible future repatriation tax, if any, to be reported differently. But once we build in a constraint on managerial behavior to the effect that the funds now can't come home, we are in the scenario where the company may keep funds abroad even if (a) the new view holds sufficiently that they in fact can't reduce the expected repatriation tax via optionality by deferring it, and also (b) they are earning less by reason of keeping the funds in broad. In short, the value of optionality aside, the PRE designation may induce managers to make shareholders worse-off - from the company's being genuinely less profitable after-tax over the long haul - simply due to their mania for high reported earnings and/or their being subject to a binding PRE constraint once they have voluntarily subjected themselves to it.

The paper explores the possibility that the firm would benefit from investing locked-out earnings in passive assets, even if they earn a lower after-tax rate of return than available active-business investment opportunities that are available to the form. The idea is that, because the passive income is taxed currently and thus can't become PRE (there are no deferred taxes to claim you will be permanently avoiding), the firm is now free to invest properly from the shareholders' standpoint, including by bringing the money home if the best opportunities are here. At the same time, the paper concedes that managers may not feel inclined to do this, given that they like to defer the current repatriation tax (even if they are not reducing its expected value) so that reported earnings can be boosted via the PRE route.

Same point holds for active income earned abroad that the managers are able to resist giving PRE status. A key broader conclusion from the paper is that it highlights some of the costs of the deferral regime once the new view either doesn't hold or is being ignored for accounting reasons. Hence my view, discussed at some length in my book, that it is important to try to delink intellectually the questions (a) what should be the domestic tax burden on foreign source income from (b) what do we think of deferral and the foreign tax credit, which are two singularly awful ways of lowering that tax burden other than by expressly applying a lower statutory rate to it.

Yesterday at the colloquium, we discussed Fadi Shaheen's above-titled paper, which is available here.

As background to the paper, the "new view" of dividend repatriations demonstrates that, if the U.S. repatriation tax for multinationals' earnings through foreign subsidiaries remains in place indefinitely at a fixed rate, and if repatriation at some point, at this fixed rate, is inevitable, then there is no lockout so far as shareholder-level economic incentives are concerned.

Thus, suppose for simplicity that there is only a U.S. tax, with no source-based foreign tax. Let's call the U.S. repatriation tax rate t, the per-period after-tax rate of return r (let's also make things simpler by assuming that you get the same after-source-tax return everywhere), and the amount of foreign source income that is at issue X. If the U.S. parent repatriates X immediately, it ends up with X(1 - t), and then at the end of the period it has X(1 - t)(1 + r). By contrast, if it repatriates at the end of the period, it has X(1 + r) to repatriate, and doing so leaves it with X(1 + r)(1 - t). Obviously (and it's a good thing too), we don't need advanced math skills to conclude that X(1 - t)(1 + r) = X(1 + r)(1 - t).

While you can kill the strict equivalence with different after-source tax rates of return as between home and abroad, all that shows is that it's desirable to keep X where it earns more, rather than less - not that the repatriation tax is discouraging repatriation. What makes the equivalence work is the fact that deferring the repatriation tax takes today's prospective liability and both discounts it at r (since it's better to pay a fixed sum later rather than now) and causes it to grow at r (since the amount to be repatriated keeps growing).

While this is an important conceptual marker that improves one understanding of the relevant incentives, the bottom-line conclusion - no lockout - is not true, because the underlying assumptions are not true. In particular, keeping they money abroad has option value, since you can simply wait for the repatriation tax rate to drop. This is especially significant when we don't just have an expectation of random walk changes in the future history of repatriation tax rates, but rather there is a very real chance that it will go down by reason of a tax holiday, corporate tax rate cut, or the enactment of another tax holiday like that in 2004.

Hence there's significant lock-out, contrary to the new view model, because only the fools among corporate CEOs and CFO's would believe that the repatriation tax rate is fixed. And whether or not these individuals are as brilliant as their paychecks are fat, they are certainly smart enough to realize that. (Further point: It's not clear that a taxable repatriation is inevitable even if we are comfortable with viewing all wealth as ultimately consumed. If capital markets work well enough, the FSI could effectively be repatriated, put in shareholders' pockets, and consumed by them without there every being a taxable repatriation.)

In the paper, howevcr, Shaheen explores the possibility of lockout if the new view is actually correct, rather than merely being an important explanatory tool. (But just one last comment on the new view - saying it's "false" in practice is no more a criticism than saying the Coase Theorem doesn't hold because there are transaction costs. That's actually, at least arguably, the point - to show us where the relevant bodies are buried.)

The paper discusses an alternative, and indeed complementary rather than contradictory explanation for lockout, which is that publicly traded firms tend to have corporate governance problems, which cause the managers to care about current or near-term financial accounting income, at the expense of actually maximizing present value. Accordingly, they seek the accounting status of "permanently reinvested earnings" (PRE) which they have persuaded their accountants will never come home. Once PRE status is attained, the deferred repatriation tax, rather than being charged against earnings as a current expense (without regard to the fact that it hasn't been paid yet), is completely ignored - valued at zero, since supposedly it is irrelevant once the managers swear on a tall enough stack of bibles that they will never repatriate particular funds.

This entry is already rather long, so I will post it now and resume in a follow-up.

Monday, January 27, 2014

Since last spring, I've been interested in writing about behavioral economics and retirement policy. In particular, I've had in mind the "nudge" literature - for example, Raj Chetty's important study along with a number of others that reach similar findings, Richard Thaler's and Cass Sunstein's book on nudges, and their related article on libertarian paternalism. These seemed to me to offer fertile and timely ground if interacted (so to speak) with both my older and my more recent work on Social Security.

But as you can perhaps see already from the way I have stated the underlying motivation, this project has been far more a bunch of thoughts and ideas in search of an overall framework, than a crisply structured project. So I was having a lot of trouble with this article idea last summer, although I did reach 30 pages or so in a fourth try that I then had to shelve for 5 months due to a host of other commitments.

By the time I had gotten my nose close enough to the water's surface to think about how I should proceed upon resuming the project, it had become clear to me that the current structure (such as it was, and if one even call call it that) was unsound. My next idea was to break it into two pieces, one about savings "incentives" (from an income tax perspective) vs. default rules vs. expanding Social Security benefits, and the other about libertarian paternalism. But this pair of projects didn't quite feel right either.

Today I am hoping - although still far from 100 percent certain - that I have finally gotten my hands around the project in a constructive way. The current plan has the tentative title "Multiple Myopias, Multiple Selves, and the Under-Saving Problem." If it does work out - which I won't really know until I've invested more hours in it - and if my schedule over the next few months proves kind to me, then perhaps I might even have it done by May.

If the current plan does indeed work out, it will have illustrated once again how much better people (I don't think I'm unusual in this regard) sometimes are at working "off-line." That is, when you're vexed by a problem, sometimes the best thing to do is get good and frustrated, then spend a couple of days not thinking about it. Always a great feeling if / when the off-line mental functions, operating beyond or beneath one's consciousness, turn out to have been studiously beavering away, such that when your conscious mind re-engages you soon find out that you have a solution.

Of course, I hope I'm not jinxing the process by implying prematurely that I have indeed found the path at last this time around.

Wednesday, January 22, 2014

Depending on how you define your terms, yesterday either did or didn't witness the semester's first PM meeting of the NYU Tax Policy Colloquium, in its nineteenth year of operations.

The introductory AM class, which is private (i.e., just for the enrolled students) went off fine despite the approach of threatening weather. But the public PM session, scheduled to meet at 4 pm, ran into a bit of a hitch when it was decided, at about 3 pm, to cancel all NYU Law School classes for the day that were scheduled to begin at 4 pm or later.

This was an entirely reasonable, and indeed probably necessary, decision given the steadily falling snow, severe temperatures, and threat of travel disruptions for people not living in the immediate area. But when you have your speaker at hand from out-of-town, have prepared extensively for the discussion, and have separately met earlier in the day both with the students and with the author to lay the groundwork for a good session, it's less than entirely welcome. We ended up holding a voluntary session (i.e., not an official class at which student attendance was expected) and had a good discussion notwithstanding.

Yesterday's author was Saul Levmore, discussing two short papers (available here and here) concerning internalities and regulation. Consider mandated saving (such as under Social Security) or cigarette taxes and smoking bans. The papers contrast the "old view," in which the underlying regulatory aims sound in externalities or paternalism, with a "new view" in which they instead aim to address people's self-control problems.

At the risk of headlining mere semantics, I don't view these alternatives as "old view" versus "new view." Usually, when we contrast such things, the two views actually contradict each other. The "old view" of corporate dividends holds that the shareholder-level tax discourages paying them. The "new view" shows that there is no such discouragement under specified circumstances. The "old view" of transition relief holds that, when there is a legal change (such as repealing the income tax exemption for municipal bonds) relief such as grandfathering should be granted, in order to protect reliance interests. The "new view" instead emphasizes incentive effects from anticipation, and thus in many circumstances favors not granting transition relief.

But in the internalities / regulatory setting we instead get related and somewhat overlapping rationales for approximately the same policies. For example, one can favor forced saving via Social Security both so the elderly won't need public support by reason of indigence and to help them optimize, if we fear they might otherwise save too little from the standpoint of their own long-term self-interest, although it is true that the two alternative rationales may have different implications for program design. (E.g., the fiscal externality would suggest requiring just enough saving to avoid public support, and indeed would suggest nothing if public support were repealed.)

I also would quibble with the papers' definition of an internality, which they extended to cover collective action problems in which each individual is acting rationally and time-consistently. An example that the papers discuss is helmet regulation. In many places that don't require motorcycle helmets, nobody wears them. Arguably, the riders have some desire to wear the helmets for safety but don't want to out themselves as nerds by doing so. But once a helmet is legally mandated, you can get the safety without causing people to view you as a nerd.

This example (probably in truth, but certainly under the stipulated facts) is a benign example of regulation working well, but I wouldn't say that it addresses an internality problem. After all, it's entirely rational not to want look like a nerd. (As Hume famously said, reason is merely the slave of the passions, and most of us have "passions" that extend to caring about how people perceive us.) There is no time-inconsistency or self-control failure in this story. Rather, it's an externality issue - if I don't wear a helmet, I affect the social meaning when someone else does - that may be difficult to solve privately due to collective action problems.

More generally, I don't have the sense that internalities transform the regulatory analysis as much as the papers suggest. Within neoclassical economics, allowing for internalities is a radical step because it challenges the basic rationality assumption, as well as greatly muddying the effort to discern preferences and utility from behavior. But once you allow yourself to take this step, the analysis goes forward in largely familiar ways. (Not entirely so, because the potentially missing "transaction" is between present and future selves, rather than different people.) The papers have some interesting things to say about how interest group politics and information problems in discerning the proper policy can be big issues in a regulatory setting where internalities are important. But this is also the case if one just has externalities to deal with.

Although I don't here comment on the sessions themselves, in order to preserve their being off-the-record, I will note that Levmore is always good value as a speaker and guest, which is one reason we scheduled him for Week 1, and also helps to explain why I did not want to lose the session.

Friday, January 17, 2014

I have just posted on SSRN a new article, entitled "The Economics of Tax Law." Despite the scope implied by the title, it's just 30 pages / 9500 words.

The abstract is as follows: "This working paper is a forthcoming chapter in the
Oxford Handbook of Law and Economics, edited by Francesco Parisi.It provides a brief overview of economic
issues in tax law, including distribution and efficiency in general, the role
of administrative and political economy concerns in an income tax, the choice
between income and consumption taxation, the significance of entity-level
taxation of corporations, and the issues raised by base-broadening tax reform."I am considering adding a short section addressing the basics of tax incidence, an issue which at present I only mention a few times in passing. The problem is that I am only 500 words shy of my overall word limit.The article is available for download here.I am hoping that it has some potential to serve as a useful overview/intro paper, such as for law students in tax and tax policy classes.

Wednesday, January 15, 2014

On Wednesday, January 29, from 9 to 10:30 am, the American Enterprise Institute will be hosting an event called "Corporate Tax Reform: Where to From Here?" Alan Viard will be the moderator, and I am one of the three speakers, along with Marty Sullivan and Laura D'Andrea Tyson.

The event description reads as follows: "Economists often condemn the inefficiency and complexity of the US
corporate income tax, and politicians on both sides of the aisle
advocate reform. Yet the US corporate tax code has remained largely
unchanged for decades. Has the time come for reform? What would an ideal
corporate income tax look like?"

This is meant to be open-ended, however, and I will talk more about the muddle of the existing system and the dilemmas that it confronts us with. I've prepared PowerPoint slides, entitled "Stand-Alone Corporate Tax Reform?," that I plan to post after the event.

Tuesday, January 07, 2014

The Amazon website appears to indicate that my new book, Fixing U.S. International Taxation, is currently available for immediate ordering. See here. I have received my advance copies, but the official pub date is not until February 5. Barnes & Noble is listing it, but just for pre-ordering. On the Amazon website, you can actually click on "Look Inside" and see a fairly significant portion of the text.

If anyone finds that it's not currently available except as a pre-order, please let me know.

Monday, January 06, 2014

Today's New York Times has an op-ed by Laurence Kotlikoff advocating abolition of the U.S. corporate income tax. To make this revenue-neutral, he'd accompany it with increasing personal income tax rates.

Kotlikoff claims that "eliminating the United States' corporate income tax produces rapid and dramatic increases in American investment, output, and real wages, making the tax cut self-financing to a significant extent." Ostensibly the "potential economic and welfare gains are stunningly large," even with an accompanying increase in personal income tax rates.

I looked quickly at the underlying paper by Kotlikoff and several coauthors, which is available here, and had the following concerns:

1) What exactly is the "corporate income tax" that we are repealing in his model? While this is not entirely clear in the paper, perhaps he means the tax on income from capital that is invested in the U.S. But this is a very different proposition indeed from the "U.S. corporate income tax." At present, lots of domestic capital income is earned outside of corporate solution, and not just for tax reasons.. Also, lots of labor income, in an economic sense, can show up as corporate income because owner-employees don't have to pay themselves arm's length salaries. Kotlikoff may view all this as merely a bunch of second order implementation details, but others might disagree.

More generally, it would be a huge mistake to think of repealing the existing corporate income tax as closely analogous in practice, even just in the steady state without regard to transition issues, to repealing the income tax and replacing it with a well-functioning progressive consumption tax. The institutional details are just too different and consequential. But once one recognizes this, one is stuck in the morass of niggling institutional details that make it harder to draw firm conclusions about anything relating to the corporate tax, especially from a very general and abstract model. See my book, Decoding the U.S. Corporate Income Tax (paperback here, Kindle here), for discussion and explication of the existing corporate income tax system's lack of a coherent economic core. This of course is not a defense of the existing system, but shows that it's harder than Kotlikoff may realize to determine what repeal of the system actually means.

2) The paper appears to contemplate consumption and/or wage tax financing to replace the lost corporate income tax revenues. By contrast, the op-ed speaks of higher personal income tax rates.

3) In the paper, the very large estimates of increased U.S. capital investment and welfare that are cited in the op-ed expressly depend on the lack of matching corporate tax reductions in other countries. This appears quite unrealistic, especially if the behavioral response is as huge as the paper's results suggest. The paper deals with the issue of matching corporate tax reductions around the world, which it unsurprisingly finds would significantly reduce the U.S. welfare gain. Perhaps the op-ed should have acknowledged this point.

4) The paper and model appear to assume that the incidence of the U.S. corporate income tax falls almost entirely on labor, presumably because capital is highly mobile and labor far less so. To the extent that this bottom line conclusion remains controversial, however, then to some extent the paper has risked assuming its conclusions. (Not much of a surprise if U.S. workers were to gain from eliminating a tax that is assumed to fall substantially or entirely on them due to the effects of cross-border capital flows.)

Economic models with greater institutional detail than that by Kotlikoff et al do not invariably find this bottom line result to be clear. (More precisely, some do, but others don't.) For example, consider this paper, which finds, for state-level corporate income taxes, that "firm owners bear roughly 40% of the incidence, while workers and land owners bear 35% and 25%, respectively." States are even more by way of being small open economies than the U.S. as a whole, although admittedly labor mobility might be higher, not just absolutely but also relative to capital mobility, within the U.S. than across national borders.

About Me

I am the Wayne Perry Professor of Taxation at New York University Law School. My research mainly emphasizes tax policy, government transfers, budgetary measures, social insurance, and entitlements reform. My most recent books are (1) Decoding the U.S. Corporate Tax (2009) and (2) Taxes, Spending, and the U.S. Government's March Toward Bankruptcy (2006). My other books include Do Deficits Matter? (1997), When Rules Change: An Economic and Political Analysis of Transition Relief and Retroactivity (2000), Making Sense of Social Security Reform (2000), Who Should Pay for Medicare? (2004), Taxes, Spending, and the U.S. Government's March Towards Bankruptcy (2006), Decoding the U.S. Corporate Tax (2009), and Fixing the U.S. International Tax Rules (forthcoming). I am also the author of a novel, Getting It. I am married with two children (boys aged 16 and 19) as well as four (!) cats. For my wife Pat's quilting blog, see Patwig’s Blog.